FOREX OUTLOOK-Euro gains likely next week, but rise seen capped

Fri Feb 18, 2011 4:35pm EST

Related Topics

* Euro zone political events could cap euro gains

* Euro/dollar technical outlook turns bullish

* US data next week unlikely to change rate outlook

(Updates prices, adds quotes, outlook)

By Gertrude Chavez-Dreyfuss

New York, Feb 18 (Reuters) - The euro is likely to add modest gains against the dollar in the upcoming week, bolstered by increased expectations of a European Central Bank rate hike and a fairly positive technical outlook in the short term.

The euro's rise, however, may be limited by a slew of political events next week that may inject uncertainty. Some analysts said the euro may get above $1.38 but was unlikely to hit $1.40.

On the charts, the euro's prospects have turned bullish, analysts said, with support clustered around $1.3250, the 61.8 percent Fibonacci retracement of the January to February rally.

Resistance comes in at $1.3745, the Feb 9 high. A break of that level should bring the rally back though $1.3862, the Feb 2. peak.

Aside from an upbeat technical view, the euro has benefited on Friday from a report citing ECB policymaker Lorenzo Bini Smaghi as saying the central bank will be ready to tighten policy as price pressures mount. [ID:nLDE71H1DZ]

"The euro looks very well supported going forward," said Richard Franulovich, senior currency strategist, at Westpac in New York. "Aside from a hawkish ECB, central banks have been buying euros for reserve diversification purposes. I think we can hit that $1.3862 high again."

The positive prognosis on the euro comes amid expectations of more political debate ahead of the election next Friday in Ireland. Terms of the European Union loans to Ireland and the fiscal consolidation plan would be two of the key issues.

There are also German regional elections, ongoing issues related to Portugal, and possible debate about the new law on capital requirement in Spain.

These may all add an element of caution in the market when trading the euro.

Overall, analysts said it may well come down to interest rate expectations. While the ECB ponders rate increases, the Federal Reserve continues its Treasury purchase program, which "was sized so as to represent about a 75-basis-point reduction in the fed funds target rate," said David Watt, senior fixed income and currency strategist, at RBC Capital Markets in Toronto.

"As the...ECB muses on rate hikes, the Fed is still effectively 'cutting' rates. Dollar rallies tend to fade when these factors are put in focus," Watt said.

Bini Smaghi's comments come just two weeks after ECB President Jean-Claude Trichet talked down the prospect of rate hikes during an ECB February press conference, an about face after sounding hawkish in January.

In late afternoon New York trading, the euro was up 0.6 percent against the dollar at $1.3685 EUR=EBS, after hitting a high of $1.3716 on electronic trading platform EBS, its highest in more than a week.

On the week, the euro rose 1.3 percent vs the dollar, rising after two straight weeks of losses.

The ICE Futures' dollar index fell 0.4 percent .DXY to 77.679.

Surprisingly the dollar, a traditional safe-haven along with the Swiss franc, failed to capitalize on heightened geopolitical tensions in the Middle East.

Westpac's Franulovich said the dollar's weakness amid tension in that region may be attributed to general low volatility across all asset classes, prompting investors to take on more risk. Implied volatilities, which tend to reflect risk sentiment in the currency market were trading near long-term lows.

Analysts said the dollar's performance next week depends on action in the euro.

"The U.S. economic numbers next week won't change the market's view on QE2 (quantitative easing), which is still expected to end in June as scheduled, or interest rate expectations," said Vassili Serebriakov, currency strategist, at Wells Fargo in New York.

Meanwhile, currency speculators continued to trim bets against the U.S. dollar in the latest week as they went short the yen for the first time since June, data from the Commodity Futures Trading Commission showed on Friday. See [ID:nN18104672]

(Additional reporting by Julie Haviv; Editing by Chizu Nomiyama)

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